Thursday, September 08, 2011

The 2011 Stimulus Proposal

A few thoughts about the $450 billion stimulus proposal that Obama presented tonight...

This is a big proposal, composed of a lot of very effective ingredients. If enacted (which it won't be, but that's another issue), this would make a noticeable difference to the recovery -- I would expect the number of jobs it would create to be in the millions, not thousands.

The good:

1. Unemployment benefits: The biggest bang for the buck would be the extension of unemployment benefits. Numerous studies show that this provides a large and direct boost to the economy.

2. Infrastructure: The proposal includes a large amount of spending on infrastructure (schools, parks, roads, bridges, mass transit), which also provides a very large bang for the buck. Furthermore, greater infrastructure spending has the tremendous advantage of yielding benefits far into the future by generally increasing the productivity of the US economy. The US's infrastructure is dreadfully underfunded and out-of-date; since we know we need to spend huge amounts of money over the next 10-20 years to fix it, why not do it now when we have lots of unemployed labor (especially construction workers) and rock-bottom interest rates?

3. Payroll tax cuts: I also like the proposal's tax cuts that go directly into the pockets of middle-income consumers, namely the extended reduction in payroll taxes for workers. Such tax cuts are almost completely spent (middle-class consumers save very little of their take-home pay), and would therefore have a very direct impact on the economy.

4. State and local government jobs: The proposal would include funding to be passed along to state and local governments so that they could avoid laying off teachers. Again, good in the short run for the US economy, and very good in the long run.

5. Mortgage refinancing: this has been covered in some detail by others, and it would have the potential to provide some real stimulus to the economy.

The not-so good:

There are a few tax cuts, credits, and so forth that I think would be of dubious value...

1. Cut payroll tax for employers: This provides little incentive to firms to hire more workers. The primary effect, I suspect, would be to increase corporate profits. Some studies assert that such employer payroll tax cuts can induce firms to reduce prices (thereby raising sales and production); but if the tax cuts are targeted only at small and medium-sized businesses, as in the Obama proposal, then that mechanism probably won't work because small and medium-sized businesses are generally price-takers, with little scope to change their prices by a significant amount.

2. Tax credits for hiring unemployed veterans: The main impact of this provision, I think, would be to inspire firms to look specifically for veterans when hiring: any firm that is going to hire someone anyway will now simply look for a veteran. But it's doubtful that many firms would create entirely new job openings just because of this provision. In other words, I would expect the main effect of this to be that firms would change the type of job candidates they are looking for, not the number of them. Good for veterans, but bad for non-veterans, with little net impact on the economy.

3. Extend 100% expensing for businesses: I'm not sure how this is supposed to help. In theory, allowing 100% expensing (i.e. deducting the full amount in year 1 of an investment that has a multiple-year useful life span) should persuade firms to move planned investments from the future into the present. But since this provision is already in place, firms have already been pushing forward whatever investments they could. I suppose that it could provide some benefit in the second half of 2012... but little to no benefit for the next 12 months.

Nevertheless, as I said, taken as a whole this was a big and ambitious proposal. And it would really help. The fact that it has no chance of passing tells us something about the US's political system right now... but I do think that Obama should get full marks for at least trying.

UPDATE: For Mark Thoma's initial reaction (which I also agree with), see here.

2 comments:

As I understand it, the payroll tax cuts are half of the $450B. They do deliver stimulus in a timely fashion. However (a) they are tilted toward the upper income spectrum, people who are likely to save them rather than spend them, (b) payroll tax cuts to employers are unlikely to be stimulative, and (C) the President has said that this has to be (in the nonsensical jargon of Washington) "paid for". He has all but issued an open invitation to the Supercommittee to cut Social Security and Medicare. He has also handed the right a potent weapon by draining the Social Security surplus at a time that the right is fearmongering about... the drop in the Social Security surplus due to the recession. The Supercommittee is very likely to repay him by enacting offsetting cuts landing at the same time as the payroll tax cut kicks in.

I call this first half of the plan, Paying for our current unemployment out of our retirement savings. Sometimes one has to do such things, but let's be clear that it creates a future danger.

The rest of the plan, with the likely exception of mortgage refi, is genuine stimulus. UE, as you say, gives strong bang for the buck. Infrastructure is good, and this is designed to hit the economy quickly. But I would argue that this is at best a $300B stimulus based on the likelihood that so much of the payroll tax cut will likely end up being saved. The time frame is unclear to me, but I'd be surprised if we see $200B of that $300B spent in the next 12 months.

Meanwhile the Supercommittee is trying to figure out how to take an annual average of $400B out of the economy.

As I said at Brad's blog, its better than a poke in the eye with a sharp stick. It might not be better than a poke in the eye with a blunt stick.</span>

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The Street Light is written by economist Kash Mansori, who works as an economic consultant (though views expressed here are entirely his own), writes whenever he can in his spare time, and teaches a bit here and there. You can contact him by writing to the gmail account streetlightblog. (More about Kash.)